Introduction

The decision of when to start vesting shares is critically important for founders of startups. Typically, vesting is a period over which shares can be earned, often over a four-year period with a one-year cliff. This article explores whether founders should start vesting at the point of incorporation to secure investor confidence and align interests, addressing both the benefits and potential pitfalls of this strategy.

Strategic Reasons for Starting Vesting at Incorporation

Investor Confidence
The primary reason to consider vesting at incorporation is to establish trust and alignment with investors. Having shares vested prior to engaging with investors demonstrates a strong commitment to the company's long-term success. This can significantly bolster investor confidence and reduce risks associated with the investment. Investors often prefer this approach as it signals a shared interest in the venture's growth and stability.

Avoiding Dilution Issues
Waiting to start vesting until after securing investment can complicate matters, particularly regarding share dilution and ownership percentages. Negotiations with investors can become more challenging if founders’ shares are not vested. By starting vesting at incorporation, founders can better manage these complexities, ensuring a smoother transition into investment deals.

Alignment with Industry Norms
Many investors adhere to a standard practice of expecting founders to have shares vested over a four-year period with a one-year cliff, aligning with common industry norms. Adhering to this schedule can make the startup more attractive to potential investors and help secure better investment terms.

Protection Against Departure
Early vesting can also provide protection against potential issues if a founder leaves the company before the investment round is completed. In such cases, unvested shares can lead to complicated ownership structures and legal complications. Vesting shares at incorporation helps mitigate these risks, ensuring a more stable and predictable ownership structure.

Legal and Tax Considerations
Vesting shares at incorporation can have tax implications for founders. Shares that are vested may be subject to capital gains tax rather than ordinary income, depending on the timing of the sale and other factors. Understanding these tax considerations is crucial for any founder to manage their finances effectively.

Caution and Individual Circumstances

While vesting at incorporation offers several advantages, it is important for founders to consult with legal and financial advisors to ensure that the vesting schedule aligns with their specific circumstances and goals. This can help avoid any unintended consequences and ensure compliance with applicable laws and regulations. Ignoring professional advice can lead to costly mistakes and legal issues.

The Dilemma of Vesting and Trust

Dichotomy Between Vested and Un-vested Shares
There is often a tension between vested and un-vested shares. Vested shares secure the founders' commitment to the company, while un-vested shares can be a source of conflict and concern. This dichotomy can create significant challenges for founders and early staff, as they may fear being replaced or rewarded based on their vesting status rather than their contributions. This can lead to dissatisfaction and potential departures.

VC Behavior and Founder Expectations
Many VCs (Venture Capitalists) and early staff can act in their own best interests, which may not always be aligned with the company's goals. This can create mistrust and conflicts. For example, if a VC or early staff member believes they will have more leverage or equity in the future, their behavior may change, leading to a potential slowdown in progress. Conversely, if founders are fully vested, they may be more motivated to succeed, as their future is tied to the company's success.

Game Theory and Motivation
From a game theory perspective, it may not always be in one's best interest to work hard when there is nothing to lose. If shares are un-vested, founders and early team members may feel they have nothing to gain or lose, leading to a potential decrease in motivation. Conversely, if shares are vested, founders have a vested interest in the company's success and are more likely to work hard to achieve this goal.

Conclusion

In conclusion, while starting vesting at incorporation can be a strategic decision for founders to enhance investor confidence, align with industry norms, and protect against departure, it is crucial to balance these benefits with potential risks. Founders should carefully consider their unique circumstances and consult with experts to ensure they make informed and strategic decisions that maximize their company's success and minimize potential conflicts.